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LPAC approval is not a “killer” for NAV financing

According to Hamilton Lane, allowing LPs to consent to NAV facilities would not hinder their introduction.

Co-CEO Juan Delgado-Moreira said Private Equity International The investment manager “called on” the GPs to ensure that the limited partners’ advisory board is consulted on the use of such facilities.

“In new LP agreements, you see the LP trying to enforce that consent,” he said. “It's simply a matter of consent – it's not about drafting agreements or restrictions and limitations. The LPAC wants to see the package and have an opinion on it.”

That power will not limit their use, he added, pointing to the growing market for continuation funds as a similar example.

“When you think about a … $75 billion market, all of that happened through consent. So nobody in the NAV market can tell me that consent is a killer. No, it's not – it hasn't stopped the continuation vehicle market.”

NAV financings are often used to facilitate new investments in existing assets or to generate synthetic distributions for LPs. Although these have become more attractive to GPs as a slowdown in exits makes raising new capital more difficult, such opportunities have proven controversial for some LPs.

According to Hamilton Lanes Market Overview Report 2024About 15 percent of managers have used NAV facilities to date. The report found that more than 20 percent of the arrangements allow borrowing without the limited partner's prior consent – a dynamic it called “abhorrent” and “ridiculous.”

However, in a Debevoise & Plimpton briefing in November, the law firm reported a “newer generation of LPAs that specifically provide for and build in mechanisms for the use of NAV funding.” It added: “With this development, we are seeing sponsors shift their focus to providing disclosures and discussions about expected leverage to investors at an earlier stage in the fundraising process.”

Delgado-Moreira, who is based in Hong Kong, said the private equity industry's fundraising challenges have given LPs more leverage in negotiating LPAs.

“The negotiation pendulum is swinging, [and] right now it's still on the LP side,” he added. “Fundraising is still increasing and we have time. And whoever has time has power for the LPs. So we expect to see more of that.”

Hamilton Lane's push for approval is based on the assumption that LPs did not enter into the commitment with the expectation that their investments would be cross-collateralized, the report says, noting that many LPs have a lower cost of capital than GPs and that borrowing at 11 percent – the mid-range of current market rates – would be a “terrible capital allocation decision.”

The company's concerns are not shared by all competitors. Just over a third (35 percent) of LPs are “neutral” on the importance of restrictions on GPs' use of NAV loans in fund documentation, according to PEI'S LP Perspectives 2024 StudyApproximately 61 percent of LPs said such restrictions were “very” or “fairly important,” up from 74 percent last year. However, the proportion of respondents who consider them “very important” has also increased.

Regardless, fund documentation can only go so far. For example, some managers have begun structuring these facilities at a “level or two below the fund” because LPAs contain fewer regulations about the capital structure of the companies owned by the vehicle in question, said Khizer Ahmed, founder and managing member of fund financing specialist Hedgewood Capital Partners. PEI In December.

“There may also be situations where general disclosures about the fund's ability to raise asset-level financing are deemed sufficient by the GP to cover fund-level NAV facilities. However, from a practitioner perspective and as a matter of best practice, we always advise GPs to engage with LPs first so that we can feel confident when discussing with prospective lenders about the fund's ability to be a borrower in a NAV financing transaction.”